3 Cost of debt Aa Aa To calculate the aftertax cost of debt

3. Cost of debt Aa Aa To calculate the after-tax cost of debt, multiply the before-tax cost of debt by Omni Consumer Products Company (OCP) can borrow funds at an interest rate of 7.30% for a period of five years. Its marginal federal-plus-state tax rate is 45%. OCP\'s after-tax cost of debt is places) (rounded to two decimal At the present time, Omni Consumer Products Company (OCP) has 5-year noncallable bonds with a face value of $1,000 that are outstanding. These bonds have a current market price of $1,050.76 per bond, carry a coupon rate of 10%, and distribute annual coupon payments. The company incurs a federal-plus-state tax rate of 45%. ÎfOCp wants to issue new debt, what would be a reasonable estimate for its after-tax cost of debt (rounded to two decimal places)? o 4.79% o 5.75% ? 4.31% ? 3.83%

Solution

1.  to calculate post tax cost of debt multiply the before tax cost of debt -----

answer :-before tax cost of debt (100% -- taxrate) before tax cost of debt is multilplied100minus tax rate

2. ocps after tax cost of debt is ----

after tax cost of debt is = intrest rate(100%-tax rate)

so after tax cost of debt is = 7.30%(100-45) = 7.30%(55%) = 4.01%

3.ocps estimate reasonable after tax cost of debt is = intrest rate (100%-taxrate)

= 10 %(100%-45%) = 10%(55%) = 5.5%

4..characteristics of preffered stock

prefered stock is hybrid stock it consist of both debt and equity

dividends are fixed is characteristics of EQUITY

no tax adjustments are made when calculating the cost of prfered stock is EQUITY  

4..Galbraith`s cost of prefered stock is = dividend per share/pricce per share

= 11/97.95 = 11.2302%